Heading into the 5pm "IM TOO TIRED TO MAKE UP A FUNNY SAYING" marking period, the FN 4.0 is +0-09 at 98-14 yielding 4.1619% and the FN 4.5 is trading +0-04 at 100-30 yielding 4.387%. The secondary market current coupon is 4.3082%.
The purpose of the charts below is to assist in the process of clarifying the concept of yield spreads and relative value. We've frequently discussed the relative performance of rate sheet influential MBS coupons vs. the performance of their benchmarks.
Terms used often to describe relative value: yield spreads are wider, yield spreads are tighter, MBS are being outperformed by benchmark big brothers, gapped out, wider, tighter, flat, basis, hedge ratio, duration, convexity etc, etc. Up to this point we havent gotten too deep into durations, convexity, hedge ratios, and other more complex topics pertinent to trading bonds with embedded call options (dont call me for three months!!!...corny call trader joke) as most readers are more concerned with lender pricing strategies vs. gaining a deeper understanding of the process used to determine the present value of future mortgage cash flow (sometimes we get a little ahead of ourselves perhaps?). However we believe having a basic understanding of relative value can be useful in gauging the market's demand for "rate sheet influential" MBS coupons.
Note: this example is not to make an assessment of relative value, it is purely to help further understand the concept of yield spread.
The first example takes place when rates are rising.
1. When MBS prices rise, MBS yields fall. Looking at both the 10yr TSY chart below and the FN 4.5 MBS chart above, you can see the inverse relationship between bond prices and bond yields. When 10yr TSY yields are falling, MBS prices are rising.
2. This morning when the 10yr TSY yield rose from 3.313% to 3.352%, the price of the FN 4.5 fell from 101-04 to 100-26.
3. As you can see from the above chart, when MBS prices fell, the FN 4.5's yield rose 0.0388% from 4.3637% to 4.4025%.
4. However when the sell off occurred the 10yr yield rose 0.039% from 3.313% to 3.352%.
5. Before the sell off the FN 4.5 yield was 105.07bps higher than the 10yr TSY yield. After the selloff the FN 4.5 yield was 105.05bps higher than the 10yr TSY yield. So the FN 4.5 outperformed the 10yr TSY note.
The second example takes occurred when rates were falling.
1. This afternoon when the 10yr TSY yield fell from 3.339% to 3.317%, FN 4.5 prices rose from 100-28 to 101-02.
2. As you can see from the chart above when MBS prices rose, the FN 4.5 yield fell 0.0233% from 4.3947% to 4.3714%.
3. However when the rally occurred, the 10yr yield fell 0.022%.
4. Before the rally the FN 4.5 yield was 105.57 basis points higher than the 10yr TSY yield. After the rally the FN 4.5 yield was 105.44bps higher than the 10yr TSY yield. So again we would say that the FN 4.5 outperformed the UST10YR note. Yield spreads were tighter.
Again...this is just an example of how MBS prices compare to returns of their benchmarks. I keep telling this because the FN 4.5 is actually wider vs. the 10yr compared to yesterday so I feel like I picked a bad example. WHOMP WHOMP More discussion on this later though....
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